Citation: 2007TCC247
Date: 20070509
Docket: 2004-1892(IT)G
BETWEEN:
MICHAEL HOLZHEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris, J.
[1] The Appellant ceased to be a resident of
Canada on November 30, 2000 and was therefore deemed by paragraph 128.1(4)(b)
of the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.) the (“Act”)
to have disposed of each property he owned at that time for proceeds equal to
their fair market value.
One of the properties the Appellant owned was a loan which he had made to a
non-resident corporation Interest had accrued on the loan up to November 30,
2000 but was not yet payable.
[2] This appeal deals with the tax consequences
of the deemed disposition of the Appellant’s right to receive the accrued
interest on the loan.
[3] The Appellant reported the proceeds from that
deemed disposition as a capital gain. By reassessment, the Minister of National
Revenue (the “Minister”) included the amount in the Appellant’s income pursuant
to paragraph 12(1)(c) of the Act as an amount received in lieu of
interest. The Appellant is appealing from that reassessment.
Facts
[4] The relevant facts are contained in an Agreed
Statement of Facts, filed by the parties, which reads as follows:
Agreed Statement of Facts
1. The Appellant
ceased to be a resident of Canada on November 30, 2000.
2. The Appellant
became a resident of Germany on December 1, 2000.
3. The Appellant
was a minor shareholder in G. Haindl'sche Papierfabriken KGaA
("Haindl") a large German corporation.
4. Over the years,
the Appellant had lent various amounts to Haindl (the "Loans").
5. The Loans were
denominated in Euros.
6. The Loans were
interest bearing.
7. The terms of
the Loans provided that interest accruing during the course of a particular
calendar year was payable in December of that year.
8. The Appellant
still held the Loans when he ceased to be a resident of Canada.
9. The interest
received on the Loans in all prior years in which the Appellant was a resident
of Canada was correctly reported by the Appellant in his income tax returns as
income in the year the interest was received.
10. From
January 1, 2000 until November 30, 2000, no interest was paid on the
Loans.
11. On
November 30, 2000, no interest was receivable on the Loans.
12. From
January 1, 2000 until November 30, 2000, interest of
$125,816 CDN accrued on the Loans (the "Accrued Interest").
13. The Appellant did
not report the Accrued Interest as interest income in his 2000 taxation year
since he had not received any interest before he ceased to be a resident on
November 30, 2000.
14. The Appellant
did, however, report all of the Accrued Interest as a capital gain arising from
a deemed disposition of the Accrued Interest on November 30, 2000 in his
2000 tax return.
15. The Minister of
National Revenue (the "Minister") reassessed the Appellant on
December 2, 2002 (the "Reassessment") on the basis that the
Accrued Interest was taxable as interest income under section 12(1)(c)
of the Income Tax Act (the "Act").
16. The Appellant
objected to the Reassessment within the time required for doing so under the
Act.
17. By Notification
of Confirmation dated January 28, 2004, the Minister confirmed the
Reassessment on the basis that the Accrued Interest was taxable as interest
income under section 12(1)(c).
18. The Appellant Reported
the Accrued Interest in his tax return in Germany.
19. The Appellant
became a resident of Canada again in January 2004.
Issues
[5] The first issue in this appeal is whether
the deemed proceeds from the deemed disposition of the right to receive the
accrued interest were received by the Appellant “in lieu of interest” within
the meaning of paragraph 12(1)(c).The relevant portions of that
provision read:
12(1) There shall be included in computing the income of a taxpayer
for a taxation year as income from a business or property such of the following
amounts as are applicable:
(c) Interest – … any amount received or receivable by the
taxpayer in the year (depending on the method regularly followed by the
taxpayer in computing the taxpayer’s income) as, on account of, in lieu of
payment of or in satisfaction of, interest to the extent that the interest was
not included in computing the taxpayer’s income for a preceding taxation year;
[6] Alternatively, the Respondent contends that
the proceeds were income from property and required to be included in the Appellant’s
income by virtue of sections 3 and 9 of the Act which read in part as
follows:
3. The income of a taxpayer for a taxation year for the
purposes of this Part is the taxpayer's income for
the year determined by the following rules:
(a)
determine the total of all
amounts each of which is the taxpayer's income for
the year (other than a taxable capital gain
from the disposition of a property) from a source inside or outside Canada, including,
without restricting the generality of the foregoing, the taxpayer's income for
the year from each office, employment, business and property,
…
9(1) Subject
to this Part, a taxpayer's income for
a taxation year from a business or property is the taxpayer's profit from
that business or property for the year.
[7] The Appellant maintains that he correctly
reported the proceeds as a capital gain
[8] In the reply to notice of appeal, the Respondent
had also put forward an argument based on subsection 20(14) of the Act,
but withdrew that argument at the hearing
Appellant’s arguments
[9] Counsel for the Appellant contends that
proceeds from the disposition of a right to receive accrued interest at a future
date are neither interest nor an amount received in lieu of interest, but are,
instead, a capital receipt. Therefore the proceeds are not taxable under
paragraph 12(1)(c).
[10] In support of this proposition, he relies
on the decision of the Federal Court Trial Division in The Queen v. Immobilière
Canada Ltd.,
which held that the disposition of a right to a future payment of accrued
interest was a disposition on capital account.
[11] In Immobilière, the taxpayer had
been assessed withholding tax on amounts it paid to purchase certain bonds from its non-resident parent corporation.
The price paid by the Appellant for the bonds included an amount equal to the
interest which had accrued on the bonds but which was not yet payable as of the
date of sale. The issue before the Court was whether the amount paid in respect
of the accrued interest was an amount paid as interest or in lieu of interest
within the meaning of section 106(1)(b) of the Act (now
subsection 212(1)(b)). The Court held at page 5334 that:
The
word "interest" in that section means interest owing on the bonds,
charge, debt or obligation and not that part of the purchase price paid by a
third party to the holder of same for a transfer of the right to the accrued
interest…
The
Court also stated that:
…where
a person purchases a debt or obligation from a creditor on which there is
accrued interest owing, the payment to the transferor of an amount required to
purchase the right to the accrued interest does not constitute payment of
interest to a transferor because the transferee is purchasing an expectancy to
receive interest and not interest.
[12] Counsel for the Appellant argues that the
deemed disposition in this case was a disposition of “an expectancy to receive
interest” and therefore that the proceeds received by the Appellant cannot be
characterized as interest or as an amount received in lieu of interest.
[13] Counsel further contends that the
reassessment constitutes the taxation of accrued interest, which is contrary to
the scheme of the Act. He says that in those cases where Parliament
wishes to tax interest on an accrual basis, it does so explicitly rather than
through paragraph 12(1)(c). He referred to subsections 12(3) and (4)
which require certain taxpayers to report interest income on an accrual basis
in certain circumstances, to subsection 20(14) which requires accrued interest
to be included income where a debt is transferred or assigned to another
person, and to paragraph 70(1)(a) which includes interest which has
accrued up to the date of death of a taxpayer in the taxpayer’s income.
[14] Counsel also referred to the decision of
this Court in David Grant and Catherine Grant v. The Queen.
In that case, the taxpayers entered into a series of transactions known as a
“departure trade” in anticipation of their ceasing to be resident in Canada. Prior to leaving Canada,
they borrowed money on which interest was payable and used the borrowed money
to purchase interest-bearing notes. They paid the interest on the borrowed
money and received the interest on the notes after leaving Canada. The taxpayers did not include any of the interest received
on the notes after their departure in their income, which was consistent with
the accounting method with they normally followed. (The judge noted that the Respondent
did not challenge this aspect of the transaction.) However, the taxpayers sought
a deduction under paragraph 114(c) of the Act for the portion of
the interest that accrued on the borrowed money before they left Canada but which was not paid until after their departure. The
issue in the appeal was whether paragraph 114(c) permitted that
deduction.
[15] This Court held that paragraph 114(c)
dealt only with deductions available in Division C of the Act for computing
taxable income and could not be interpreted so as to permit the deduction of
interest. The Court determined that any interest deduction to which a taxpayer
might be entitled formed part of the computation of income made under paragraph
114(a) using Division B of the Act. Division B includes subsection
20(1)(c) which deals with the deduction of interest.
[16] In coming to this conclusion, the judge
said:
If Parliament had intended that cash basis taxpayers like the
appellant be allowed to deduct interest on an accrual basis, which is what the
appellants are effectively suggesting, it is likely that Parliament would have
enacted a specific provision that modified paragraph 114(a) to
explicitly give that result, rather than grafting on an overlapping provision
in paragraph 114(c).
And that:
... the interpretation suggested by the appellants would have the
result that cash basis taxpayers could claim interest expense on an accrual
basis and yet report the related interest income on a cash basis ... An
interpretation that gives this result should not be preferred over another
interpretation unless it is clear that parliament intends this result.
[17] In this case, counsel for the Appellant
suggests that the Respondent’s interpretation of paragraph 12(1)(c)
would result in cash basis taxpayers being required to report interest on an
accrual basis, and says that, in the absence of clear language to that effect,
the Respondent's interpretation should be rejected.
[18] Counsel also submitted that the Respondent’s
interpretation of paragraph 12(1)(c) could lead to double taxation in
certain circumstances. He provided two hypothetical situations, each quite
different from the facts of this case.
[19] The first example involved a person who
both ceased to be a resident of Canada and then returned to Canada in the same taxation year. That person had made a
loan prior to leaving Canada. Accrued interest was outstanding on the
loan at the time the taxpayer left Canada and is not
paid until after returning to Canada.
[20] In the second example, interest on a loan
becomes receivable by the taxpayer prior to his leaving Canada. The interest is not paid on time and is still owing
to the taxpayer when he leaves the country. The taxpayer normally follows the
accrual method of accounting in calculating his income from property.
[21] The Appellant’s counsel contends that the
amount of accrued interest would be included twice in income in each of these
cases if the deemed disposition of the amounts receivable by the taxpayers are
considered to give rise to a receipt of an amount in lieu of interest.
Respondent’s arguments
[22] Counsel for the Respondent submits that the
proceeds in this case were received by the Appellant in lieu of interest due to
him, and therefore fall clearly within the wording of paragraph 12(1)(c).
[23] Counsel relies on the Federal Court of
Appeal decision in Transocean Offshore Ltd. v. The Queen,
where the Court considered the meaning of the phrase “in lieu of” in the
context of paragraph 212(1)(d) of the Act.
[24] In Transocean, the taxpayer received
a payment from a group of Canadian co‑venturers as compensation for an
anticipatory breach of an agreement under which rent would have been payable to
the taxpayer for the use of an offshore drilling rig. The Minister assessed the
taxpayer pursuant to paragraph 212(1)(d) on the basis that the payment
was made in lieu of rent.
[25] The relevant portions of paragraph 212(1)(d)
read as follows:
212. (1) Every
non-resident person shall pay an income tax of 25% on every amount that a person
resident in Canada pays . . . to the non-resident person as, on account or in
lieu of payment of, or in satisfaction of,
. . .
(d)
rent, royalty or similar payment, including, but not so as to restrict the
generality of the foregoing, any payment
[26] The taxpayer in Transocean contended
that since the rental agreement was repudiated before the commencement of the
rental term, the property was never used and no amount of rent ever became
payable, and therefore no amount could be said to have been paid in lieu of rent.
The taxpayer relied on the Exchequer
Court decision in Puder v.
The Minister of National Revenue,
which held that a payment that is made “in lieu of interest” is an amount that
serves the same function as interest.
[27] In Puder, the taxpayer had
loaned money on the security of the mortgage which was repayable with interest.
The borrower repaid the entire mortgage prior to the end of its term and was
required to pay the taxpayer a “bonus” representing the interest that would
have become payable for the remainder of the mortgage term. The question
before the Court was whether this amount was received by the taxpayer as
interest or as an amount paid in lieu of interest. The Court held that since
the principal of the loan had been repaid, the bonus was not interest because
it could not be related to the period when the mortgage was outstanding nor
could it be related to the use of the money during the remainder of the mortgage
term. The Court also found that the amount was not received in lieu of interest
“since no part of the amount ever accrued as interest and no part of it was
paid in lieu of or in satisfaction of any amount that ever accrued as
interest.”
[28] The Court of Appeal said in Transocean
that Puder imposed “an unjustifiably narrow meaning on the phrase “in
lieu of” and stated that:
… the ordinary meaning of that phrase connotes something that takes
the place of something else or as a substitute for something else.
Theoretically, a thing may take the place of another thing if it performs
exactly the same function as that other thing, or if it performs a function
that is not exactly the same but is a reasonable substitute. Puder recognizes
the first possibility but rejects the second, without suggesting any
justification for doing so.
[29] Counsel for the Respondent submits that the
Immobilière decision also involves an unjustifiably narrow
interpretation of the phrase “in lieu of”, similar to that found in Puder,
and that Immobilière, therefore, should not be followed.
[30] The Respondent says that by using the words
“in lieu of” Parliament intended to expand the scope of paragraph 12(1)(c)
to include payments other than payments that have the legal character of
interest and that since the Appellant’s gain on the deemed disposition resulted
from his lending money to Haindl and from earning interest thereon, the gain
was a payment in lieu of interest.
[31] Finally, counsel submitted that, if the
gain is found not to have been received in lieu of interest, it should be
included in the Appellant’s income as income from property. The gain was
generated from property and was a direct result of the Appellant’s ownership of
property. Therefore, the gain represents income earned from a source that is
property and must be included by the Appellant in his income pursuant to paragraph
3(a) of the Act.
Analysis
[32] In my view, the
decision of the Federal Court of Appeal in Transocean is determinative
of the question of whether the deemed proceeds from the deemed disposition of
the right to the accrued interest in this case was received “in lieu of”
interest. Paragraph 12(1)(c) uses language that is substantially similar
to the language of paragraph 212(1)(d) considered by the Court in Transocean.
[33] Paragraph 12(1)(c)
requires a taxpayer to include in income any amount received or receivable by
the taxpayer in the year “as, on account of, in lieu of payment of or in
satisfaction of, interest”, whereas paragraph 212(1)(d), applies to
amounts paid “as, on account of or in lieu of payment of, or in satisfaction
of, ... rent, royalty or similar payment ...”
[34] In Transocean,
the Federal Court of Appeal observed at paragraph 47 that:
An amount that
is paid instead of a payment of a particular legal character, or in the place
of such a payment, does not have that same legal character. Parliament, in
using the words “in lieu of” in paragraph 212(1)(d) must have intended
to expand the scope of paragraph 212(1)(d) to include payments other
than payments that have the legal character of rent.
The
Court went on to say that:
“a thing may
take the place of another if it performs exactly the same function as that
other thing, or if it performs a function that is not exactly the same but is a
reasonable substitute.”
[35] The particular question
that must be answered is whether the deemed proceeds in this case were a
reasonable substitute for the interest earned on the loan to Haindl which were
not yet payable.
[36] In Transocean, the Federal Court of Appeal found
that the amount paid in respect of the anticipatory breach of the rental
agreement was a reasonable substitute for rent payable under the agreement. In
this case the link between the deemed proceeds and the accrued interest is, in
my view, even stronger since the loan had already been made to Haindl and
interest had already accrued before the deemed disposition occurred
[37] The amount of
interest which accrued in respect of the period up to November 30, 2000, could
be precisely calculated pursuant to the loan agreement, and, according to the
agreed statement of facts, the fair market value of the right to receive this
accrued interest was the same amount as the interest which had accrued on the
loan from January 1, 2000 until November 30, 2000. On this basis it can readily
be seen that the deemed proceeds were a reasonable substitute for the accrued
interest.
[38] I agree with
counsel for the Respondent that the Immobilière decision can no longer
be relied upon in light of the decision of the Federal Court of Appeal in Transocean.
While the Court in Transocean did not refer to Immobilière, it is indistiguishable
from the Exchequer Court decision in Puder, and Puder was
found in Transocean to have placed “an unjustifiably narrow meaning
on the phrase “in lieu of”. Therefore, in my view, proceeds received from a
disposition of the “expectancy to receive interest” are a reasonable substitute
for interest and therefore would be received in lieu of interest within the
meaning of paragraph 12(1)(c) of the Act.
[39] I am not convinced that the Appellant has
shown any reason that I should not follow the Federal Court of Appeal’s
interpretation of the phrase “in lieu of” in Transocean.
[40] I disagree with the Appellant’s argument
that the scheme of the Act regarding accrued interest would support a
narrow interpretation of that phrase. I do not believe that the manner in
which the Act treats accrued interest that has not been received or
become receivable is relevant to the issue in this appeal. The Minister in this
case is not attempting to tax accrued interest. The amount sought to be
included in income is the proceeds from the deemed disposition of property. The deemed
receipt of the proceeds triggers the inclusion in income. As with any amount
received by a taxpayer, the nature of the receipt determines whether it is
required to be included in income or not. In this case, the payment was
received “in lieu of interest” and is required to be added to the Appellant’s
income.
[41] The Grant case cited by counsel for the
Appellant also only dealt with interest which had accrued but which had not
been paid or become payable at the relevant time and can be distinguished on
that basis from the case before me. Interestingly, it appears that in Grant
neither the taxpayers, in reporting their income, nor the Minister, in
assessing, included the proceeds from the deemed disposition of the accrued
interest at the time they left Canada. The judge in Grant noted that the Respondent
did not take issue with the fact that the taxpayers did not include in
computing income any amount in respect of the interest they received on the
notes, and paragraph 128.1(4) was seemingly not relied on in assessing.
[42] Finally, the Appellant does not allege that
double taxation arises in this case, only that in certain hypothetical circumstances
the Respondent’s interpretation of paragraph 12(1)(c) could possibly have
this result. This factor, alone, is not a sufficient basis for interpreting the
phrase “in lieu of” in the manner suggested by the Appellant.
[43] In light of my conclusion that the proceeds
from the deemed disposition of the Appellant's right to the accrued interest in
this case were properly included in his income pursuant to paragraph 12(1)(c)
of the Act as an amount received in lieu of interest, it is not
necessary for me to deal with the Respondent's alternative submission that the
amounts were income from property.
[44] For all of these
reasons, the appeal is
dismissed, with costs.
Signed at Ottawa, Canada, this 9th day of May 2007.
“Brent Paris”
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